cost_and_management_acc_accounting-manual

Colin Drury
Cost and
Management
Accounting
Sixth Edition
Students’
Manual
A u s t r a l i a • C a n a d a • M e x i c o • S i n g a p o r e • S p a i n • U n i t e d K i n g d o m • U n i t e d S t a t e s

Cost and Management Accounting 6e: Students Manual
Colin Drury
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Contents
Part 1: Questions 1
An introduction to cost terms and concepts 3
Accounting for direct costs 5
Cost assignment for indirect costs 9
Accounting entries for a job costing system 14
Process costing 19
Joint and by-product costing 23
Income effects of alternative cost accumulation systems 27
Cost-volume-profit analysis 30
Cost estimation and cost behaviour 35
Measuring relevant costs and revenues for decision-making 37
The application of linear programming to management accounting 42
Activity-based costing 44
Decision-making under conditions of risk and uncertainty 47
Capital investment decisions 49
The budgeting process 52
Management control systems 55
Standard costing and variance analysis 61
Part 2: Solutions 65
An introduction to cost terms and concepts 67
Accounting for direct costs 70
Cost assignment for indirect costs 76
Accounting entries for a job costing system 82
Process costing 89
Joint and by-product costing 97
Income effects of alternative cost accumulation systems 102
Cost-volume-profit analysis 108
Cost estimation and cost behaviour 115
Measuring relevant costs and revenues for decision-making 117
The application of linear programming to management accounting 122
Activity-based costing 126
Decision-making under conditions of risk and uncertainty 131
Capital investment decisions 134
The budgeting process 138
Management control systems 142
Standard costing and variance analysis 148

(i) Costs may be classified in a number of ways including classification by behav-
iour, by function, by expense type, by controllability and by relevance.
(ii) Management accounting should assist in EACH of the planning, control and
decision making processes in an organisation.
Discuss the ways in which relationships between statements (i) and (ii) are relevant
in the design of an effective management accounting system.
(15 marks)
ACCA Information for Control and Decision Making
(a) ‘Discretionary costs are troublesome because managers usually find it difficult
to separate and quantify the results of their use in the business, as compared
with variable and other fixed costs.’
You are required to discuss the above statement and include in your answer
the meaning of discretionary costs, variable costs and fixed costs; give two
illustrations of each of these three named costs.
(12 marks)
(b) A drug company has initiated a research project which is intended to develop a
new product. Expenditures to date on this particular research total £500 000 but
it is now estimated that a further £200 000 will need to be spent before the
product can be marketed. Over the estimated life of the product the profit
potential has a net present value of £350 000.
You are required to advise management whether they should continue or
abandon the project. Support your conclusion with a numerate statement and
state what kind of cost is the £500 000.
(5 marks)
(c) Opportunity costs and notional costs are not recognised by financial accounting
systems but need to be considered in many decisions taken by management.
You are required to explain briefly the meanings of opportunity costs and
notional costs; give two examples of each to illustrate the meanings you have
attached to them.
(8 marks)
(Total 25 marks)
CIMA Stage 2 Cost Accounting
(a) Distinguish between ‘opportunity cost’ and ‘out of pocket cost’ giving a
numerical example of each using your own figures to support your answer.
(6 marks)
(b) Jason travels to work by train to his 5-days a week job. Instead of buying daily
tickets he finds it cheaper to buy a quarterly season ticket which costs £188 for
13 weeks.
Debbie, an acquaintance, who also makes the same journey, suggests that
they both travel in Jason’s car and offers to give him £120 each quarter towards
his car expenses. Except for weekend travelling and using it for local college
Question SM 2.1
Question SM 2.2
Question SM 2.3
Relevant costs
and cost
behaviour
AN INTRODUCTION TO COST TERMS AND CONCEPTS 3
An introduction to cost terms and
concepts

attendance near his home on three evenings each week to study for his CIMA
Stage 2, the car remains in Jason’s garage.
Jason estimates that using his car for work would involve him, each quarter,
in the following expenses:
(£)
Depreciation (proportion of annual figure) 200
Petrol and oil 128
Tyres and miscellaneous 52
You are required to state whether Jason should accept Debbie’s offer and to
draft a statement to show clearly the monetary effect of your conclusion.
(5 marks)
(c) A company with a financial year 1 September to 31 August prepared a sales
budget which resulted in the following cost structure:
% of sales
Direct materials 32
Direct wages 18
Production overhead: variable 6
fixed 24
Administrative and selling costs: variable 3
fixed 7
Profit 10
After ten weeks, however, it became obvious that the sales budget was too
optimistic and it has now been estimated that because of a reduction in sales
volume, for the full year, sales will total £2 560 000 which is only 80% of the
previously budgeted figure.
You are required to present a statement for management showing the
amended sales and cost structure in £s and percentages, in a marginal
costing format.
(4 marks)
(Total 15 marks)
4 AN INTRODUCTION TO COST TERMS AND CONCEPTS

A company currently remunerates its factory workers on a time basis and is now
considering the introduction of alternative methods of remuneration. The follow-
ing information relates to two employees for one week:
Y Z
Hours worked 44 40
Rate of pay per hour £3.50 £4.50
Units of output achieved 480 390
The time allowed for each unit of output is seven standard minutes. For purposes
of piecework calculations each minute is valued at £0.05.
Required:
(a) Calculate the earnings of each employee where earnings are based on:
(i) piecework rates with earnings guaranteed at 80% of pay calculated on an
hourly basis; (4 marks)
(ii) premium bonus scheme in which bonus (based on 75% of time saved) is
added to pay calculated on an hourly basis. (3 marks)
(b) Describe two situations in which the time basis of remuneration is likely to be
more appropriate than piecework schemes. (4 marks)
(Total 11 marks)
AAT Cost Accounting and Budgeting
(a) Describe the characteristics of factory direct and indirect labour cost and
explain the treatment of factory overtime wages and holiday pay in cost
accounting systems. (9 marks)
(b) A Ltd makes engineering components. The company has been manufacturing
6000 components per week, with six direct employees working a 40-hour week,
at a basic wage of £4.00 per hour. Each worker operates independently.
A new remuneration scheme is being introduced. Each employee will receive pay-
ment on the following basis:
first 800 components per week – 16 pence per unit
next 200 17
all additional 18
There will be a guaranteed minimum wage of £140 per week. It is expected that
output will increase to 6600 components per week with the new scheme.
Required:
Describe the general features of time-based and individual-performance-based
remuneration systems, and outline the relative merits of each type of system. (Use
the above figures to illustrate your discussion, making whatever additional
assumptions that you feel are necessary.) (16 marks)
(Total 25 marks)
ACCA Level 1 Costing
Question SM 3.1
Calculation of
earnings
Question SM 3.2
Calculation of
earnings and a
discussion of
time-based and
individual
performance-
based
remuneration
systems
ACCOUNTING FOR DIRECT COSTS 5
Accounting for direct costs

X Ltd has an average of 42 workers employed in one of its factories in a period dur-
ing which 7 workers left and were replaced.
The company pays a basic rate of £4.60 per hour to all its direct personnel. This is
used as the standard rate. In addition, a factory-wide bonus scheme is in operation.
A bonus of half of the efficiency ratio in excess of 100% is added as a percentage to
the basic hourly rate, e.g. if the efficiency ratio is 110% then the hourly rate is £4.83
(i.e. £4.60 + (£4.60 × 5%)).
During the period 114 268 units of the company’s single product were manufac-
tured in 4900 hours. The standard hour is 22 units.
Required:
(a) Calculate the labour turnover percentage for the period. (3 marks)
(b) Identify the reasons for, and cost of, labour turnover, and discuss how it may
be reduced (12 marks)
(c) Calculate the hourly wage rate paid for the period, and the total labour variance.
(10 marks)
(Total 25 marks)
ACAA Cost and Management Accounting I
(a) Explain how the following cost items, relating to direct personnel, would be
processed in a manufacturing business’s cost accounts:
(i) idle time; (3 marks)
(ii) overtime. (3 marks)
(b) The following information is available regarding the labour costs in a factory
department for a week:
Direct personnel Indirect personnel
Payroll hours:
Production 432 117
Training 24 —
Idle time 32 4
Total 488 121
Rates per hour:
Basic £7.50 £6.00
Overtime premium £2.50 £2.00
The following additional information is provided:
(i) There are 12 direct personnel and 3 indirect personnel in the department.
(ii) Group bonuses for the week, shared by all workers in the department,
total £520.
(iii) The basic wage rates apply to a normal working week of 37 hours.
(iv) Overtime is worked in order to meet the general requirements of production.
(v) The idle time and the time spent training during the week are regarded as
normal.
(vi) The expected number of payroll hours of direct personnel in the week
(excluding time spent training), required to produce the output achieved,
is 470.
Required:
(i) Calculate the total amounts paid in the week (before share of group bonus) to
direct personnel and indirect personnel respectively. (4 marks)
(ii) Determine the total amounts to be charged as direct wages and indirect
wages respectively. (5 marks)
(iii) Complete the Wages Control Account in the company’s separate cost account-
ing system, clearly indicating the account in which each corresponding entry
would be made. (3 marks)
Question SM 3.3
Calculation of
labour turnover
and efficiency
ratio
Question SM 3.4
Computation of
earnings and
analysis by direct
and indirect
categories
6 ACCOUNTING FOR DIRECT COSTS

(iv) Calculate the efficiency ratio relating to the direct personnel (expressed as a
percentage to one decimal place). (2 marks)
(Total 20 marks)
ACCA Management Information – Paper 3
On 1 January Mr G started a small business selling a special yarn. He invested his
savings of £40 000 in the business and during the next six months the following
transactions occurred:
Yarn Yarn
purchases Total sales Total
Date of quantity cost Date of quantity value
receipt (box) (£) despatch (box) (£)
13 Jan 200 7 200 10 Feb 500 25 000
8 Feb 400 15 200
11 Mar 600 24 000 20 Apr 600 27 000
12 Apr 400 14 000
15 June 500 14 000 25 June 400 15 200
The yarn is stored in premises Mr G has rented, and the closing stock of yarn,
counted on 30 June, was 500 boxes.
Other expenses incurred, and paid in cash, during the six-month period
amounted to £2300.
Required:
(a) Calculate the value of the material issues during the six-month period, and
the value of the closing stock at the end of June, using the following methods
of pricing:
(i) first in, first out;
(ii) last in, last out;
(iii) weighted average (calculations to two decimal places only). (10 marks)
(b) Calculate and discuss the effect each of the three methods of material pricing
will have on the reported profit of the business, and examine the performance
of the business during the first six-month period. (12 marks)
(Total 22 marks)
(a) Write short notes to explain each of the following in the context of materials
control:
(i) Continuous stocktaking.
(ii) Perpetual inventory system.
(iii) ABC inventory analysis. (9 marks)
(b) State the factors that should influence the decision regarding economic order
quantities of raw materials. (7 marks)
(c) Calculate three normal control levels, which may be used in stock control sys-
tems, from the following information for a particular raw material:
Economic order quantity, 12 000 kilos
Lead time, 10 to 14 working days
Average usage, 600 kilos per day
Minimum usage, 400 kilos per day
Maximum usage, 800 kilos per day (9 marks)
(Total 25 marks)
Question SM 3.5
Stores pricing
Question SM 3.6
ACCOUNTING FOR DIRECT COSTS 7

A large local government authority places orders for various stationery items at
quarterly intervals.
In respect of an item of stock coded A32, data are:
annual usage quantity 5000 boxes
minimum order quantity 500 boxes
cost per box £2
Usage of material is on a regular basis and on average, half of the amount pur-
chased is held in inventory. The cost of storage is considered to be 25% of the
inventory value. The average cost of placing an order is estimated at £12.50.
The chief executive of the authority has asked you to review the present situa-
tion and to consider possible ways of effecting cost savings. You are required to:
(a) tabulate the costs of storage and ordering item A32 for each level of orders
from four to twelve placed per year;
(b) ascertain from the tabulation the number of orders which should be placed in a
year to minimize these costs;
(c) produce a formula to calculate the order level which would minimize these
costs – your answer should explain each constituent part of the formula and
their relationships;
(d) give an example of the use of the formula to confirm the calculation in (b) above;
(e) calculate the percentage saving on the annual cost which could be made by
using the economic order quantity system;
(f) suggest two other approaches which could be introduced in order to reduce the
present cost of storage and ordering of stationery.
(25 marks)
CIMA Cost Accounting 2
A company is reviewing its stock policy, and has the following alternatives avail-
able for the evaluation of stock number 12 789:
(i) Purchase stock twice monthly, 100 units
(ii) Purchase monthly, 200 units
(iii) Purchase every three months, 600 units
(iv) Purchase six monthly, 1200 units
(v) Purchase annually, 2400 units.
It is ascertained that the purchase price per unit is £0.80 for deliveries up to 500 units.
A 5% discount is offered by the supplier on the whole order where deliveries are 501
up to 1000, and 10% reduction on the total order for deliveries in excess of 1000.
Each purchase order incurs administration costs of £5.
Storage, interest on capital and other costs are £0.25 per unit of average stock
quantity held.
You are required to advise management on the optimum order size.
(9 marks)
AAT
Question SM 3.7
Economic order
quantity
Question SM 3.8
Calculation of
optimum order
size
8 ACCOUNTING FOR DIRECT COSTS

Knowing that you are studying for the CIMA qualification, a friend who manages a
small business has sought your advice about how to produce quotations in
response to the enquiries which her business receives. Her business is sheet metal
fabrication – supplying ducting for dust extraction and air conditioning installa-
tions. She believes that she has lost orders recently through the use of a job cost
estimating system which was introduced, on the advice of her auditors, seven
years ago. You are invited to review this system.
Upon investigation, you find that a plant-wide percentage of 125% is added to
prime costs in order to arrive at a selling price. The percentage added is intended to
cover all overheads for the three production departments (Departments P, Q and
R), all the selling, distribution and administration costs, and the profit.
You also discover that the selling, distribution and administration costs equate to
roughly 20% of total production costs, and that to achieve the desired return on
capital employed, a margin of 20% of sales value is necessary.
You recommend an analysis of overhead cost items be undertaken with the
objective of determining a direct labour hour rate of overhead absorption for each
of the three departments work passes through. (You think about activity-based
costing but feel this would be too sophisticated and difficult to introduce at the
present time.)
There are 50 direct workers in the business plus 5 indirect production people.
From the books, records and some measuring, you ascertain the following infor-
mation which will enable you to compile an overhead analysis spreadsheet, and to
determine overhead absorption rates per direct labour hour for departmental over-
head purposes:
Cost/expense Annual Basis for
amount apportionment
where allocation
not given
£
Repairs and maintenance 62 000 Technical assessment:
P £42 000, Q £10 000, R £10 000
Depreciation 40 000 Cost of plant and equipment
Consumable supplies 9 000 Direct labour hours
Wage-related costs 87 000 12.5% of direct wages costs
Indirect labour 90 000 Direct labour hours
Canteen/rest/smoke room 30 000 Number of direct workers
Business rates and insurance 26 000 Floor area
Question SM 4.1
Overhead
analysis,
calculation of
overhead rates
and a product
cost
COST ASSIGNMENT FOR INDIRECT COSTS 9
Cost assignment for indirect costs

Other estimates/information
Department Department Department
P Q R
Estimated direct labour hours 50 000 30 000 20 000
Direct wages costs £386 000 £210 000 £100 000
Number of direct workers 25 15 10
Floor area in square metres 5 000 4 000 1 000
Plant and equipment, at cost £170 000 £140 000 £90 000
Required:
(a) Calculate the overhead absorption rates for each department, based on direct
labour hours. (9 marks)
(b) Prepare a sample quotation for Job 976, utilising information given in the ques-
tion, your answer to (a) above, and the following additional information:
Estimated direct material cost: £800
Estimated direct labour hours: 30 in Department P
10 in Department Q
5 in Department R
(3 marks)
(c) Calculate what would have been quoted for Job 976 under the ‘auditors’ sys-
tem’ and comment on whether your friend’s suspicions about lost business
could be correct. (3 marks)
(Total 15 marks)
DC Limited is an engineering company which uses job costing to attribute costs to
individual products and services provided to its customers. It has commenced the
preparation of its fixed production overhead cost budget for 2001 and has identi-
fied the following costs:
(£000)
Machining 600
Assembly 250
Finishing 150
Stores 100
Maintenance 80
1 180
The stores and maintenance departments are production service departments.
An analysis of the services they provide indicates that their costs should be
apportioned accordingly:
Machining Assembly Finishing Stores Maintenance
Stores 40% 30% 20% — 10%
Maintenance 55% 20% 20% 5% —
The number of machine and labour hours budgeted for 2001 is:
Machining Assembly Finishing
Machine hours 50 000 4 000 5 000
Labour hours 10 000 30 000 20 000
Requirements:
(a) Calculate appropriate overhead absorption rates for each production department
for 2001. (9 marks)
Question SM 4.2
Calculation of
overhead rates
and a product
cost
10 COST ASSIGNMENT FOR INDIRECT COSTS

(b) Prepare a quotation for job number XX34, which is to be commenced early in
2001, assuming that it has:
Direct materials costing £2400
Direct labour costing £1500
and requires:
Machine Labour
hours hours
Machining department 45 10
Assembly department 5 15
Finishing department 4 12
and that profit is 20% of selling price. (5 marks)
(c) Assume that in 2001 the actual fixed overhead cost of the assembly department
totals £300 000 and that the actual machine hours were 4200 and actual labour
hours were 30 700.
Prepare the fixed production overhead control account for the assembly
department, showing clearly the causes of any over-/under-absorption. (5 marks)
(d) Explain how activity based costing would be used in organisations like DC
Limited. (6 marks)
(Total marks 25)
CIMA Stage 2 Operational Cost Accounting
A manufacturing company has two production cost centres (Departments A and B)
and one service cost centre (Department C) in its factory.
A predetermined overhead absorption rate (to two decimal places of £) is estab-
lished for each of the production cost centres on the basis of budgeted overheads
and budgeted machine hours.
The overheads of each production cost centre comprise directly allocated costs
and a share of the costs of the service cost centre.
Budgeted production overhead data for a period is as follows:
Department A Department B Department C
Allocated costs £217 860 £374 450 £103 970
Apportioned costs £45 150 £58 820 (£103 970)
Machine hours 13 730 16 110
Direct labour hours 16 360 27 390
Actual production overhead costs and activity for the same period are:
Department A Department B Department C
Allocated costs £219 917 £387 181 £103 254
70% of the actual costs of Department C are to be apportioned to production cost
centres on the basis of actual machine hours worked and the remainder on the
basis of actual direct labour hours.
Required:
(a) Establish the production overhead absorption rates for the period. (3 marks)
(b) Determine the under- or over-absorption of production overhead for the
period in each production cost centre. (Show workings clearly.) (12 marks)
(c) Explain when, and how, the repeated distribution method may be applied in
the overhead apportionment process. (5 marks)
(Total 20 marks)
Question SM 4.3
Calculation of
overhead
absorption rates
and under/over-
recovery of
overheads

(a) One of the factories in the XYZ Group of companies absorbs fixed production
overheads into product cost using a predetermined machine hour rate.
In Year 1, machine hours budgeted were 132 500 and the absorption rate for
fixed production overheads was £18.20 per machine hour. Overheads absorbed
and incurred were £2 442 440 and £2 317 461 respectively.
In Year 2, machine hours were budgeted to be 5% higher than those actually
worked in Year 1. Budgeted and actual fixed production overhead expenditure
were £2 620 926 and £2 695 721 respectively, and actual machine hours were
139 260.
Required:
Analyse, in as much detail as possible, the under-/over-absorption of fixed
production overhead occurring in Years 1 and 2, and the change in absorption
rate between the two years. (15 marks)
(b) Contrast the use of
(i) blanket as opposed to departmental overhead absorption rates;
(ii) predetermined overhead absorption rates as opposed to rates calculated
from actual activity and expenditure. (10 marks)
(Total 25 marks)
ACCA Cost and Management Accounting 1
(a) C Ltd is a manufacturing company. In one of the production departments in
its main factory a machine hour rate is used for absorbing production over-
head. This is established as a predetermined rate, based on normal activity.
The rate that will be used for the period which is just commencing is £15.00
per machine hour. Overhead expenditure anticipated, at a range of activity
levels, is as follows:
Activity level (£)
(machine hours)
1500 25 650
1650 26 325
2000 27 900
Required:
Calculate:
(i) the variable overhead rate per machine hour;
(ii) the total budgeted fixed overhead;
(iii) the normal activity level of the department; and
(iv) the extent of over-/under-absorption if actual machine hours are 1700 and
expenditure is as budgeted. (10 marks)
(b) In another of its factories, C Ltd carries out jobs to customers’ specifications. A
particular job requires the following machine hours and direct labour hours in
the two production departments:
Machining Finishing
Department Department
Direct labour hours 25 28
Machine hours 46 8
Direct labour in both departments is paid at a basic rate of £4.00 per hour. 10%
of the direct labour hours in the finishing department are overtime hours, paid
at 125% of basic rate. Overtime premiums are charged to production overhead.
The job requires the manufacture of 189 components. Each component
requires 1.1 kilos of prepared material. Loss on preparation is 10% of
unprepared material, which costs £2.35 per kilo.
Question SM 4.4
Analysis of under/
over recovery of
overheads and a
discussion of
blanket versus
department
overheads
Question SM 4.5
Calculation of
fixed and variable
overhead rates,
normal activity
level and
under/over-
recovery of
overheads
12 COST ASSIGNMENT FOR INDIRECT COSTS

Overhead absorption rates are to be established from the following data:
Machining Finishing
Department Department
Production overhead £35 280 £12 480
Required:
(i) Calculate the overhead absorption rate for each department and justify the
absorption method used.
(ii) Calculate the cost of the job. (15 marks)
(Total 25 marks)
ACCA Level 1
A company reapportions the costs incurred by two service cost centres, materials
handling and inspection, to the three production cost centres of machining, finish-
ing and assembly.
The following are the overhead costs which have been allocated and apportioned
to the five cost centres:
(£000)
Machining 400
Finishing 200
Assembly 100
Materials handling 100
Inspection 50
Estimates of the benefits received by each cost centre are as follows:
Materials
Machining Finishing Assembly handling Inspection
% % % % %
Materials handling 30 25 35 — 10
Inspection 20 30 45 5 —
You are required to:
(a) calculate the charge for overhead to each of the three production cost centres,
including the amounts reapportioned from the two service centres, using:
(i) the continuous allotment (or repeated distribution) method;
(ii) an algebraic method; (15 marks)
(b) comment on whether reapportioning service cost centre costs is generally
worthwhile and suggest an alternative treatment for such costs; (4 marks)
(c) discuss the following statement: ‘Some writers advocate that an under- or
over-absorption of overhead should be apportioned between the cost of goods
sold in the period to which it relates and to closing stocks. However, the
United Kingdom practice is to treat under- or over-absorption of overhead as
a period cost.’ (6 marks)
(Total 25 marks)
CIMA Stage 2 Cost Accounting 3
Question SM 4.6
Reapportionment
of service
department costs

14 ACCOUNTING ENTRIES FOR A JOB COSTING SYSTEM
Set out below are incomplete cost accounts for a period for a manufacturing business:
Stores Ledger Control Account
Opening Balance £60 140
Cost Ledger Control A/c £93 106
£153 246 £153 246
Production Wages Control Account
Cost Ledger Control A/c Finished Goods A/c £87 480
Production O’hd Control A/c
Production Overhead Control Account
Cost Ledger Control A/c £116 202
Prod. Wages Control A/c
Finished Goods Control Account
Opening Balance £147 890 Prod. Cost of Sales (variable)
Closing Balance £150 187
Note
1. Raw materials:
Issues of materials from stores for the period:
Material Y: 1164 kg (issued at a periodic weighted average price, calculated
to two decimal places of £). Other materials: £78 520.
No indirect materials are held on the Stores ledger.
Transactions for Material Y in the period:
Opening stock: 540 kg, £7663
Purchases: 1100 kg purchased at £14.40 per kg
2. Payroll:
Direct Indirect
workers workers
Hours worked:
Basic time 11 140 4 250
Overtime 1 075 405
Productive time – direct workers 11 664
Basic hourly rate (£) 7.50 5.70
Overtime, which is paid at basic rate plus one third, is regularly worked to meet
production targets.
Question SM 5.1
Integrated
accounts and
computation of
the net profit
Accounting entries for a job costing
system

3. Production overheads:
The business uses a marginal costing system. 60% of production overheads are
fixed costs. Variable production overhead costs are absorbed at a rate of 70% of
actual direct labour.
4. Finished goods:
There is no work in progress at the beginning or end of the period, and a Work in
Progress Account is not kept. Direct materials issued, direct labour and production
overheads absorbed are transferred to the Finished Goods Control Account.
Required:
(a) Complete the above four accounts for the period, by listing the missing
amounts and descriptions. (13 marks)
(b) Provide an analysis of the indirect labour for the period. (3 marks)
(c) Calculate the contribution and the net profit for the period, based on the cost
accounts prepared in (a) and using the following additional information:
Sales £479 462
Selling and administration overheads:
variable £38 575
fixed £74 360
(4 marks)
(Total 20 marks)
A company manufactures two products (A and B). In the period just ended pro-
duction and sales of the two products were:
Product A Product B
(000 units) (000 units)
Production 41 27
Sales 38 28
The selling prices of the products were £35 and £39 per unit for A and B respectively.
Opening stocks were:
Raw materials £72 460
Finished goods:
Product A £80 640 (3200 units)
Product B £102 920 (3100 units)
Raw material purchases (on credit) during the period totalled £631 220. Raw mater-
ial costs per unit are £7.20 for Product A and £11.60 for Product B.
Direct labour hours worked during the period totalled 73 400 (1 hour per unit of
Product A and 1.2 hours per unit of Product B), paid at a basic rate of £8.00 per hour.
3250 overtime hours were worked by direct workers, paid at a premium of 25%
over the basic rate. Overtime premiums are treated as indirect production costs.
Other indirect labour costs during the period totalled £186 470 and production
overhead costs (other than indirect labour) were £549 630. Production overheads
are absorbed at a rate of £10.00 per direct labour hour (including £6.80 per hour for
fixed production overheads). Any over-/under-absorbed balances are transferred to
the Profit and Loss Account in the period in which they arise. Non-production
overheads totalled £394 700 in the period.
Required:
(a) Prepare the following accounts for the period in the company’s integrated
accounting system:
(i) Raw material stock control;
(ii) Production overhead control;
(iii) Finished goods stock control (showing the details of the valuation of clos-
ing stocks as a note). (12 marks)
Question SM 5.2
Integrated
accounts, profits
computation and
reconciliation
relating to
absorption and
marginal costing
ACCOUNTING ENTRIES FOR A JOB COSTING SYSTEM 15

(b) Prepare the Profit and Loss Account for the period, clearly showing sales, pro-
duction cost of sales and gross profit for each product. (4 marks)
(c) Calculate, and explain, the difference in the net profit (loss) for the period if the
marginal costing method is employed. (4 marks)
(Total 20 marks)
A company has been carrying out work on a number of building contracts (includ-
ing Contract ABC) over the six-month period ended 31 May 2002. The following
information is available:
All contracts Contract ABC
(including ABC)
Number of contracts 10 —
worked on in the
six months to 31.5.02
Value £76.2 m £6.4 m
Duration 8–22 months 11 months
(average 13 months)
Contract months 531 6
Direct labour costs in the period £9.762 m £1.017 m
Raw material costs in the period £10.817 m £1.456 m
Distance from base 16 kilometres (average) 23 kilometres
Value of work certified at 31.5.02 — £5.180 m
Note:
1Contract months for ‘All Contracts’ are the sum of the number of months’ work on each individual
contract during the six-month period.
Contract ABC commenced on 1 September 2001. As at 30 November 2001 cumula-
tive costs on the contract, held in work-in-progress, totalled £1.063 m (including
overheads).
The company confidently predicts that further cost after 31 May 2002 to com-
plete Contract ABC on time (including overheads) will not exceed £0.937 m.
Overheads incurred over the six-month period to 31 May 2002, which are to be
apportioned to individual contracts are:
£m
Stores operations 1.56
Contract general management 1.22
Transport 1.37
General administration 4.25
The bases of apportionment are:
Stores operations
– contract value × contract months
Contract general management
– direct labour costs
Transport
– distance from base × contract months
General administration
– contract months
Required:
(a) (i) Apportion overheads to Contract ABC for the six-month period to 31 May
2002 (to the nearest £000 for each overhead item). (6 marks)
(ii) Determine the expected profit/loss on Contract ABC, and the amount of
profit/loss on the contract that you recommend be included in the accounts
of the company for the six-month period to 31 May 2002. (7 marks)
Question SM 5.3
Computation of
contract profit

(b) The company is introducing a service costing system into its stores operations
department.
Outline the key factors to consider when introducing the service costing system.
(7 marks)
(Total 20 marks)
A construction company is currently undertaking three separate contracts and
information relating to these contracts for the previous year, together with other
relevant data, is shown below.
Construction
services
Contract Contract Contract dept
MNO PQR STU overhead
(000) (000) (000) (000s)
Contract price 800 675 1100
Balances brought forward
at beginning of year:
Cost of work completed — 190 370 —
Material on site — — 25 —
Written-down value of
plant and machinery — 35 170 12
Wages accrued — 2 — —
Profit previously transferred
to profit/loss a/c — — 15 —
Transactions during year:
Material delivered to site 40 99 180 —
Wages paid 20 47 110 8
Payments to subcontractors — — 35 —
Salaries and other costs 6 20 25 21
Written down value of plant:
issued to sites 90 15 — —
transferred from sites — 8 — —
Balances carried forward at
the end of year:
Material on site 8 — — —
Written-down value of
plant and machinery 70 — 110 5
Wages accrued — 5 — —
Pre-payments to
subcontractors — — 15 —
Value of work certified
at end of year 90 390 950 —
Cost of work not certified
at end of year — — 26 —
The cost of operating the construction services department, which provides tech-
nical advice to each of the contracts, is apportioned over the contracts in propor-
tion to wages incurred. Contract STU is scheduled for handing over to the
contractee in the near future and the site engineer estimates that the extra costs
required to complete the contract in addition to those tabulated above, will total
£138 000. This amount includes an allowance for plant depreciation, construction
services and for contingencies.
ACCOUNTING ENTRIES FOR A JOB COSTING SYSTEM 17
Question SM 5.4
Contract costing

Required:
(a) Construct a cost account for each of the three contracts for the previous year
and show the cost of the work completed at the year end. (9 marks)
(b) (i) Recommend how much profit or loss should be taken, for each contract, for
the previous year. (7 marks)
(ii) Explain the reasons for each of your recommendations in (b) (i) above.
(6 marks)
(Total 22 marks)

A chemical compound is made by raw material being processed through two
processes. The output of Process A is passed to Process B where further material is
added to the mix. The details of the process costs for the financial period number
10 were as shown below:
Process A
Direct material 2000 kilograms at 5 per kg
Direct labour £7200
Process plant time 140 hours at £60 per hour
Process B
Direct material 1400 kilograms at £12 per kg
Direct labour £4200
Process plant time 80 hours at £72.50 per hour
The departmental overhead for Period 10 was £6840 and is absorbed into the costs
of each process on direct labour cost.
Process A Process B
Expected output was 80% of input 90% of input
Actual output was 1400 kg 2620 kg
Assume no finished stock at the beginning of the period and no work in progress at
either the beginning or the end of the period.
Normal loss is contaminated material which is sold as scrap for £0.50 per kg
from Process A and £1.825 per kg from Process B, for both of which immediate
payment is received.
You are required to prepare the accounts for Period 10, for
(i) Process A,
(ii) Process B,
(iii) Normal loss/gain,
(iv) Abnormal loss/gain,
(v) Finished goods,
(vi) Profit and loss (extract).
(15 marks)
A firm operates a process, the details of which for the period were as follows. There
was no opening work-in-progress. During the period 8250 units were received
from the previous process at a value of £453 750, labour and overheads were
£350 060 and material introduced was £24 750. At the end of the period the closing
work-in-progress was 1600 units, which were 100% complete in respect of materi-
als, and 60% complete in respect of labour and overheads. The balance of units
were transferred to finished goods.
Question SM 6.1
Preparation of
process accounts
with all output
fully completed
Question SM 6.2
Equivalent
production and no
losses
PROCESS COSTING 19
Process costing

Requirements:
(a) Calculate the number of equivalent units produced. (3 marks)
(b) Calculate the cost per equivalent unit. (2 marks)
(c) Prepare the process account. (7 marks)
(d) Distinguish between joint products and by-products, and briefly explain the
difference in accounting treatment between them. (3 marks)
(Total 15 marks)
CIMA Stage 1 Cost Accounting and Quantitative Methods
A company manufactures a product that requires two separate processes for its
completion. Output from Process 1 is immediately input to Process 2.
The following information is available for Process 2 for a period:
(i) Opening work-in-progress units:
12 000 units: 90% complete as to materials, 50% complete as to conversion costs.
(ii) Opening work-in-progress value:
Process 1 output: £13 440
Process 2 materials added: £4970
Conversion costs: £3120.
(iii) Costs incurred during the period:
Process 1 output: £107 790 (95 000 units)
Process 2 materials added: £44 000
Conversion costs: £51 480.
(iv) Closing work-in-progress units
10 000 units: 90% complete as to materials, 70% complete as to conversion costs.
(v) The product is inspected when it is complete. 200 units of finished product
were rejected during the period, in line with the normal allowance. Units
rejected have no disposal value.
Required:
(a) Calculate the unit cost of production for the period in Process 2 (to three
decimal places of £), using the periodic weighted average method. (7 marks)
(b) Prepare the Process 2 Account for the period using the unit cost of production
calculated in (a) above. (5 marks)
(c) Explain why, and how, the Process 2 Account would be different if there was
no normal allowance for rejects. NB The process account should not be
reworked. (5 marks)
(d) Explain how the process account workings, required in (a) above to calculate
the unit cost, would differ if the FIFO valuation method was used instead.
(3 marks)
(Total 20 marks)
Chemical Processors manufacture Wonderchem using two processes, mixing and
distillation. The following details relate to the distillation process for a period
No opening work in progress (WIP)
Input from mixing 36 000 kg at a cost of £166 000
Labour for period £43 800
Overheads for period £29 200
Closing WIP of 8000 kg, which was 100% complete for materials and 50% complete
for labour and overheads.
The normal loss in distillation is 10% of fully complete production. Actual loss in
the period was 3600 kg, fully complete, which were scrapped.
Required:
(a) Calculate whether there was a normal or abnormal loss or abnormal gain for
the period. (2 marks)
Question SM 6.3
Losses in process
(weighted
average)
Question SM 6.4
Losses in process
(weighted
average)
20 PROCESS COSTING

(b) Prepare the distillation process account for the period, showing clearly weights
and values. (10 marks)
(c) Explain what changes would be required in the accounts if the scrapped
production had a resale value, and give the accounting entries. (3 marks)
(Total 15 marks)
(a) Z Ltd manufactures metal cans for use in the food processing industry. The
metal is introduced in sheet form at the start of the process. Normal wastage in
the form of offcuts is 2% of input. The offcuts can be sold for £0.26 per kilo.
Each metal sheet weighs 2 kilos and is expected to yield 80 cans. In addition to
wastage through offcuts, 1% of cans manufactured are expected to be rejected.
These rejects can also be sold at £0.26 per kilo.
Production, and costs incurred, in the month just completed, were as follows:
Production: 3 100 760 cans
Costs incurred:
Direct materials: 39 300 metal sheets at £2.50 per sheet
Direct labour and overhead: £33 087
There was no opening or closing work in process.
Required:
Prepare the process accounts for the can manufacturing operation for the
month just completed. (15 marks)
(b) Another of the manufacturing operations of Z Ltd involves the continuous pro-
cessing of raw materials with the result that, at the end of any period, there are
partly completed units of product remaining.
Required:
With reference to the general situation outlined above
(i) explain the concept of equivalent units (3 marks)
(ii) describe, and contrast, the FIFO and average methods of work in process
valuation. (7 marks)
(Total 25 marks)
The manufacture of one of the products of A Ltd requires three separate processes.
In the last of the three processes, costs, production and stock for the month just
ended were:
(1) Transfers from Process 2: 180 000 units at a cost of £394 200.
(2) Process 3 costs: materials £110 520, conversion costs £76 506.
(3) Work in process at the beginning of the month: 20 000 units at a cost of £55 160
(based on FIFO pricing method). Units were 70% complete for materials, and
40% complete for conversion costs.
(4) Work in process at the end of the month: 18 000 units which were 90% complete
for materials, and 70% complete for conversion costs.
(5) Product is inspected when it is complete. Normally no losses are expected but
during the month 60 units were rejected and sold for £1.50 per unit.
Required:
(a) Prepare the Process 3 account for the month just ended. (15 marks)
(b) Explain how, and why, your calculations would be affected if the 60 units lost
were treated as normal losses. (5 marks)
(c) Explain how your calculations would be affected by the use of weighted
average pricing instead of FIFO. (5 marks)
(Total 25 marks)
Question SM 6.5
Preparation of
process accounts
with output fully
completed and a
discussion of
FIFO and average
methods of WIP
valuation
Question SM 6.6
FIFO method and
losses in process
PROCESS COSTING 21

A company operates several production processes involving the mixing of ingredi-
ents to produce bulk animal feedstuffs. One such product is mixed in two separate
process operations. The information below is of the costs incurred in, and output
from, Process 2 during the period just completed.
Costs incurred: £
Transfers from Process 1 187 704
Raw materials costs 47 972
Conversion costs 63 176
Opening work in process 3 009
Production: Units
(100% complete, apart from Process 2
conversion costs which were 50% complete)
Transfers from Process 1 112 000
Completed output 105 400
Closing work in process 1 600
(100% complete, apart from Process 2
conversion costs which were 75% complete)
Normal wastage of materials (including product transferred from Process 1), which
occurs in the early stages of Process 2 (after all materials have been added), is
expected to be 5% of input. Process 2 conversion costs are all apportioned to units
of good output. Wastage materials have no saleable value.
Required:
(a) Prepare the Process 2 account for the period, using FIFO principles. (15 marks)
(b) Explain how, and why, your calculations would have been different if wastage
occurred at the end of the process. (5 marks)
(Total 20 marks)
ACCA Cost and Management Accounting
Question SM 6.7
FIFO method and
losses in process
22 PROCESS COSTING

PQR Limited produces two joint products – P and Q – together with a
by-product R, from a single main process (process 1). Product P is sold at the point of
separation for £5 per kg, whereas product Q is sold for £7 per kg after further process-
ing into product Q2. By-product R is sold without further processing for £1.75 per kg.
Process 1 is closely monitored by a team of chemists, who planned the output
per 1000 kg of input materials to be as follows:
Product P 500 kg
Product Q 350 kg
Product R 100 kg
Toxic waste 50 kg
The toxic waste is disposed of at a cost of £1.50 per kg, and arises at the end of
processing.
Process 2, which is used for further processing of product Q into product Q2, has
the following cost structure:
Fixed costs £6000 per week
Variable costs £1.50 per kg processed
The following actual data relate to the first week of accounting period 10:
Process 1
Opening work in process Nil
Materials input 10 000 kg costing £15 000
Direct labour £10 000
Variable overhead £4 000
Fixed overhead £6 000
Outputs:
Product P 4800 kg
Product Q 3600 kg
Product R 1000 kg
Toxic waste 600 kg
Closing work in progress nil
Process 2
Opening work in process nil
Input of product Q 3600 kg
Output of product Q2 3300 kg
Closing work in progress 300 kg,
50% converted
Conversion costs were incurred in accordance with the planned cost structure.
Question SM 7.1
Preparation of
joint product
account and a
decision on
further
processing
JOINT AND BY-PRODUFCT COSTING 23
Joint and by-product costing

Required:
(a) Prepare the main process account for the first week of period 10 using the final
sales value method to attribute pre-separation costs to joint products. (12 marks)
(b) Prepare the toxic waste accounts and process 2 account for the first week of
period 10. (9 marks)
(c) Comment on the method used by PQR Limited to attribute pre-separation costs
to its joint products. (4 marks)
(d) Advise the management of PQR Limited whether or not, on purely financial
grounds, it should continue to process product Q into product Q2:
(i) if product Q could be sold at the point of separation for £4.30 per kg; and
(ii) if 60% of the weekly fixed costs of process 2 were avoided by not processing
product Q further. (5 marks)
(Total 30 marks)
A distillation plant, which works continuously, processes 1000 tonnes of raw mater-
ial each day. The raw material costs £4 per tonne and the plant operating costs per
day are £2600. From the input of raw material the following output is produced:
(%)
Distillate X 40
Distillate Y 30
Distillate Z 20
By-product B 10
From the initial distillation process, Distillate X passes through a heat process which
costs £1500 per day and becomes product X which requires blending before sale.
Distillate Y goes through a second distillation process costing £3300 per day and
produces 75% of product Y and 25% of product X1.
Distillate Z has a second distillation process costing £2400 per day and produces
60% of product Z and 40% of product X2. The three streams of products X, X1 and
X2 are blended, at a cost of £1555 per day to become the saleable final product XXX.
There is no loss of material from any of the processes.
By-product B is sold for £3 per tonne and such proceeds are credited to the
process from which the by-product is derived.
Joint costs are apportioned on a physical unit basis.
(a) draw a flow chart, flowing from left to right, to show for one day of production
the flow of material and the build up of the operating costs for each product;
(18 marks)
(b) present a statement for management showing for each of the products XXX, Y
and Z, the output for one day, the total cost and the unit cost per tonne;
(5 marks)
(c) suggest an alternative method for the treatment of the income receivable for
by-product B than that followed in this question (figures are not required).
(2 marks)
(Total 25 marks)
Question SM 7.2
Flow chart and
calculation of cost
per unit for joint
products
24 JOINT AND BY-PRODUCT COSTING

A chemical company carries on production operations in two processes. Materials
first pass through process I, where a compound is produced. A loss in weight takes
place at the start of processing. The following data, which can be assumed to be
representative, relates to the month just ended:
Quantities (kg):
Material input 200 000
(half processed)
Work completed 160 000
Closing work in process 30 000
(two-thirds processed)
Costs (£):
Material input 75 000
Processing costs 96 000
Opening work in process:
Materials 20 000
Processing costs 12 000
Any quantity of the compound can be sold for £1.60 per kg. Alternatively, it can be
transferred to process II for further processing and packing to be sold as Starcomp
for £2.00 per kg. Further materials are added in process II such that for every kg of
compound used, 2 kg of Starcomp result.
Of the 160 000 kg per month of work completed in process I, 40 000 kg are sold as
compound and 120 000 kg are passed through process II for sale as Starcomp. Process
II has facilities to handle up to 160 000 kg of compound per month if required. The
monthly costs incurred in process II (other than the cost of the compound) are:
120 000 kg 160 000 kg
of compound of compound
input input
Materials (£) 120 000 160 000
Processing costs (£) 120 000 140 000
Required:
(a) Determine, using the average method, the cost per kg of compound in process
I, and the value of both work completed and closing work in process for the
month just ended. (11 marks)
(b) Demonstrate that it is worth while further processing 120 000 kg of compound.
(5 marks)
(c) Calculate the minimum acceptable selling price per kg, if a potential buyer
could be found for the additional output of Starcomp that could be produced
with the remaining compound. (6 marks)
(Total 22 marks)
C Ltd operates a process which produces three joint products. In the period just
ended costs of production totalled £509 640. Output from the process during the
period was:
Product W 276 000 kilos
Product X 334 000 kilos
Product Y 134 000 kilos
Question SM 7.3
Calculation of
cost per unit and
decision on
further
processing
Question SM 7.4
Profitability
analysis and a
decision on
further
processing
JOINT AND BY-PRODUCT COSTING 25

There were no opening stocks of the three products. Products W and X are sold in
this state. Product Y is subjected to further processing. Sales of Products W and X
during the period were:
Product W 255 000 kilos at £0.945 per kilo
Product X 312 000 kilos at £0.890 per kilo
128 000 kilos of Product Y were further processed during the period. The balance of
the period production of the three products W, X and Y remained in stock at the
end of the period. The value of closing stock of individual products is calculated by
apportioning costs according to weight of output.
The additional costs in the period of further processing Product Y, which is con-
verted into Product Z, were:
Direct labour £10 850
Production overhead £7 070
96 000 kilos of Product Z were produced from the 128 000 kilos of Product Y. A by-
product BP is also produced which can be sold for £0.12 per kilo. 8000 kilos of BP
were produced and sold in the period.
Sales of Product Z during the period were 94 000 kilos, with a total revenue of
£100 110. Opening stock of Product Z was 8000 kilos, valued at £8640. The FIFO
method is used for pricing transfers of Product Z to cost of sales.
Selling and administration costs are charged to all main products when sold, at
10% of revenue.
Required:
(a) Prepare a profit and loss account for the period, identifying separately the
profitability of each of the three main products. (14 marks)
(b) C Ltd has now received an offer from another company to purchase the total
output of Product Y (i.e. before further processing) for £0.62 per kilo. Calculate
the viability of this alternative. (5 marks)
(c) Discuss briefly the methods of, and rationale for, joint cost apportionment.
(6 marks)
(Total 25 marks)
ACCA Level 1 Cost and Management Accounting 1
26 JOINT AND BY-PRODUCT COSTING

A company sells a single product at a price of £14 per unit. Variable manufacturing
costs of the product are £6.40 per unit. Fixed manufacturing overheads, which are
absorbed into the cost of production at a unit rate (based on normal activity of 20 000
units per period), are £92 000 per period. Any over- or under-absorbed fixed manu-
facturing overhead balances are transferred to the profit and loss account at the end
of each period, in order to establish the manufacturing profit.
Sales and production (in units) for two periods are as follows:
Period 1 Period 2
Sales 15 000 22 000
Production 18 000 21 000
The manufacturing profit in Period 1 was reported as £35 800.
Required:
(a) Prepare a trading statement to identify the manufacturing profit for Period 2
using the existing absorption costing method. (7 marks)
(b) Determine the manufacturing profit that would be reported in Period 2 if
marginal costing was used. (4 marks)
(c) Explain, with supporting calculations:
(i) the reasons for the change in manufacturing profit between Periods 1 and 2
where absorption costing is used in each period; (5 marks)
(ii) why the manufacturing profit in (a) and (b) differs. (4 marks)
(Total 20 marks)
R Limited is considering its plans for the year ending 31 December 2001. It makes
and sells a single product, which has budgeted costs and selling price as follows:
£ per unit
Selling price 45
Direct materials 11
Direct labour 8
Production overhead:
variable 4
fixed 3
Selling overhead:
variable 5
fixed 2
Administration overhead:
fixed 3
Fixed overhead costs per unit are based on a normal annual activity level of 96 000
units. These costs are expected to be incurred at a constant rate throughout the year.
Question SM 8.1
Preparation of
variable and
absorption
costing profit
statements and an
explanation of the
change in profits
Question SM 8.2
Preparation of
variable and
absorption
costing profit
statements and
CVP analysis
INCOME EFFECTS OF ALTERNATIVE COST ACCUMULATION SYSTEMS 27
Income effects of alternative cost
accumulation systems

Activity levels during January and February 2001 are expected to be:
January February
units units
Sales 7000 8750
Production 8500 7750
Assume that there will be no stocks held on 1 January 2001.
Required:
(a) Prepare, in columnar format, profit statements for each of the two months of
January and February 2001 using:
(i) absorption costing;
(ii) marginal costing. (12 marks)
(b) Reconcile and explain the reasons for any differences between the marginal
and absorption profits for each month which you have calculated in your
answer to (a) above. (3 marks)
(c) Based upon marginal costing, calculate:
(i) the annual breakeven sales value; and
(ii) the activity level, in units, which will yield an annual profit of £122 800.
(6 marks)
(d) Explain 3 fundamental assumptions underpinning single product breakeven
analysis. (6 marks)
(Total 27 marks)
CIMA Stage 2 – Operational Cost Accounting
The following budgeted profit statement has been prepared using absorption costing
principles:
January to July to
June December
(£000) (£000) (£000) (£000)
Sales 540 360
Opening stock 100 160
Production costs:
Direct materials 108 36
Direct labour 162 54
Overhead 90 30
460 280
Closing stock 160 80
300 200
GROSS PROFIT 240 160
Production overhead:
(Over)/Under absorption (12) 12
Selling costs 50 50
Distribution costs 45 40
Administration costs 80 80
163 182
NET PROFIT/(LOSS) 77 (22)
Sales units 15 000 10 000
Production units 18 000 6 000
Question SM 8.3
Preparation of
variable and
absorption
costing
statements as a
reconciliation of
the profits
28 INCOME EFFECTS OF ALTERNATIVE COST ACCUMULATION SYSTEMS

The members of the management team are concerned by the significant change in
profitability between the two six-month periods. As management accountant, you
have analysed the data upon which the above budget statement has been pro-
duced, with the following results:
1. The production overhead cost comprises both a fixed and a variable element, the
latter appears to be dependent on the number of units produced. The fixed ele-
ment of the cost is expected to be incurred at a constant rate throughout the year.
2. The selling costs are fixed.
3. The distribution cost comprises both fixed and variable elements, the latter
appears to be dependent on the number of units sold. The fixed element of the
cost is expected to be incurred at a constant rate throughout the year.
4. The administration costs are fixed.
Required:
(a) Present the above budgeted profit statement in marginal costing format.
(10 marks)
(b) Reconcile EACH of the six-monthly profit/loss values reported respectively
under marginal and absorption costing. (4 marks)
(c) Reconcile the six-monthly profit for January to June from the absorption
costing statement with the six-monthly loss for July to December from the
absorption costing statement. (4 marks)
(d) Calculate the annual number of units required to break even. (3 marks)
(e) Explain briefly the advantages of using marginal costing as the basis of
providing managers with information for decision making. (4 marks)
(Total 25 marks)
The following information relates to product J, for quarter 3, which has just ended:
Production Sales Fixed Variable
(units) (units) overheads costs
(£000) (£000)
Budget 40 000 38 000 300 1800
Actual 46 000 42 000 318 2070
The selling price of product J was £72 per unit.
The fixed overheads were absorbed at a predetermined rate per unit.
At the beginning of quarter 3 there was an opening stock of product J of 2000
units, valued at £25 per unit variable costs and £5 per unit fixed overheads.
Required:
(a) (i) Calculate the fixed overhead absorption rate per unit for the last quarter,
and present profit statements using FIFO (first in, first out) using:
(ii) absorption costing;
(iii) marginal costing; and
(iv) reconcile and explain the difference between the profits or losses. (12 marks)
(b) Using the same data, present similar statements to those required in part (a).
Using the AVECO (average cost) method of valuation, reconcile the profit or
loss figures, and comment briefly on the variations between the profits or
losses in (a) and (b). (8 marks)
(Total 20 marks)
ACCA Paper 8 Managerial Finance
Question SM 8.4
Preparation of
variable and
absorption
costing profit
statements for
FIFO and AVECO
methods
INCOME EFFECTS OF ALTERNATIVE COST ACCUMULATION SYSTEMS 29

30 COST–VOLUME–PROFIT ANALYSIS
(a) From the following information you are required to construct:
(i) a break-even chart, showing the break-even point and the margin of safety;
(ii) a chart displaying the contribution level and the profit level;
(iii) a profit–volume chart.
Sales 6000 units at
£12 per unit = £72 000
Variable costs 6000 units at
£7 per unit = £42 000
Fixed costs = £20 000
(9 marks)
(b) State the purposes of each of the three charts in (a) above. (6 marks)
(c) Outline the limitations of break-even analysis. (5 marks)
(d) What are the advantages of graphical presentation of financial data to executives?
(2 marks)
(Total 22 marks)
AAT
A company produces and sells two products with the following costs:
Product X Product Y
Variable costs £0.45 £0.6
(per £ of sales)
Fixed costs £1 212 000 £1 212 000
per period
Total sales revenue is currently generated by the two products in the following
proportions:
Product X 70%
Product Y 30%
Required:
(a) Calculate the break-even sales revenue per period, based on the sales mix
assumed above. (6 marks)
(b) Prepare a profit–volume chart of the above situation for sales revenue up to
£4 000 000. Show on the same chart the effect of a change in the sales mix to
product X 50%, product Y 50%. Clearly indicate on the chart the break-even
point for each situation. (11 marks)
(c) Of the fixed costs £455 000 are attributable to product X. Calculate the sales
revenue required on product X in order to recover the attributable fixed
costs and provide a net contribution of £700 000 towards general fixed costs
and profit. (5 marks)
(Total 22 marks)
Question SM 9.1
Break-even,
contribution and
profit–volume
graph
Question SM 9.2
Profit–volume
graph and
changes in sales
mix
Cost–volume–profit analysis

M Ltd manufactures three products which have the following revenue and costs
(£ per unit).
Product 1 2 3
Selling price 2.92 1.35 2.83
Variable costs 1.61 0.72 0.96
Fixed costs:
Product-specific 0.49 0.35 0.62
General 0.46 0.46 0.46
Unit fixed costs are based upon the following annual sales and production volumes
(thousand units):
Product 1 2 3
98.2 42.1 111.8
Required:
(a) Calculate:
(i) the break-even point sales (to the nearest £ hundred) of M Ltd based on the
current product mix; (9 marks)
(ii) the number of units of Product 2 (to the nearest hundred) at the break-
even point determined in (i) above; (3 marks)
(b) Comment upon the viability of Product 2. (8 marks)
(Total 20 marks)
You are employed as an accounting technician by Smith, Williams and Jones, a
small firm of accountants and registered auditors. One of your clients is Winter plc,
a large department store. Judith Howarth, the purchasing director for Winter plc,
has gained considerable knowledge about bedding and soft furnishings and is con-
sidering acquiring her own business.
She has recently written to you requesting a meeting to discuss the possible pur-
chase of Brita Beds Ltd. Brita Beds has one outlet in Mytown, a small town 100
miles from where Judith works. Enclosed with her letter was Brita Beds’ latest
profit and loss account. This is reproduced below.
Brita Beds Ltd
Profit and loss account – year to 31 May
Sales (units) (£)
Model A 1 620 336 960
Model B 2 160 758 160
Model C 1 620 1 010 880
Turnover 2 106 000
Expenses (£)
Cost of beds 1 620 000
Commission 210 600
Transport 216 000
Rates and insurance 8 450
Light heat and power 10 000
Assistants’ salaries 40 000
Manager’s salary 40 000 2 145 050
Loss for year 39 050
Question SM 9.3
Calculation of
break-even points
based on different
sales mix
assumptions and
a product
abandonment
decision
Question SM 9.4
Calculation of
break-even points
and limiting factor
decision-making
COST–VOLUME–PROFIT ANALYSIS 31

Also included in the letter was the following information:
1. Brita Beds sells three types of bed, models A to C inclusive.
2. Selling prices are determined by adding 30% to the cost of beds.
3. Sales assistants receive a commission of 10% of the selling price for each bed sold.
4. The beds are delivered in consignments of 10 beds at a cost of £400 per
delivery. This expense is shown as ‘Transport’ in the profit and loss account.
5. All other expenses are annual amounts.
6. The mix of models sold is likely to remain constant irrespective of overall
sales volume.
Task 1
In preparation for your meeting with Judith Howarth, you are asked to calculate:
(a) the minimum number of beds to be sold if Brita Beds is to avoid making a loss;
(b) the minimum turnover required if Brita Beds it to avoid making a loss.
At the meeting, Judith Howarth provides you with further information:
1. The purchase price of the business is £300 000.
2. Judith has savings of £300 000 currently earning 5% interest per annum, which
she can use to acquire Beta Beds.
3. Her current salary is £36 550.
To reduce costs, Judith suggests that she should take over the role of manager as
the current one is about to retire. However, she does not want to take a reduction
in income. Judith also tells you that she has been carrying out some market
research. The results of this are as follows:
1. The number of households in Mytown is currently 44 880.
2. Brita Beds Ltd is the only outlet selling beds in Mytown.
3. According to a recent survey, 10% of households change their beds every 9 years,
60% every 10 years and 30% every 11 years.
4. The survey also suggested that there is an average of 2.1 beds per household.
Task 2
Write a letter to Judith Howarth. Your letter should:
(a) identify the profit required to compensate for the loss of salary and interest;
(b) show the number of beds to be sold to achieve that profit;
(c) calculate the likely maximum number of beds that Brita Beds would sell in a year;
(d) use your answers in (a) to (c) to justify whether or not Judith Howarth should
purchase the company and become its manager;
(e) give two possible reasons why your estimate of the maximum annual sales
volume may prove inaccurate.
On receiving your letter, Judith Howarth decides she would prefer to remain as
the purchasing director for Winter plc rather than acquire Brita Beds Ltd. Shortly
afterwards, you receive a telephone call from her. Judith explains that Winter plc
is redeveloping its premises and that she is concerned about the appropriate sales
policy for Winter’s bed department while the redevelopment takes place.
Although she has a statement of unit profitability, this had been prepared before
the start of the redevelopment and had assumed that there would be in excess of
800 square metres of storage space available to the bed department. Storage space
is critical as customers demand immediate delivery and are not prepared to wait
until the new stock arrives.

The next day, Judith Howarth sends you a letter containing a copy of the original
statement of profitability. This is reproduced below:
Model A B C
Monthly demand 35 45 20
(beds) (£) (£) (£)
Unit selling price 240.00 448.00 672.00
Unit cost per bed 130.00 310.00 550.00
Carriage inwards 20.00 20.00 20.00
Staff costs 21.60 40.32 60.48
Department fixed overheads 20.00 20.00 20.00
General fixed overheads 25.20 25.20 25.20
Unit profit 23.20 32.48 (3.68)
Storage required per
bed (square metres) 3 4 5
In her letter she asks for your help in preparing a marketing plan which will maxi-
mize the profitability of Winter’s bed department while the redevelopment takes
place. To help you, she has provided you with the following additional information:
1 Currently storage space available totals 300 square metres.
2 Staff costs represent the salaries of the sales staff in the bed department. Their total
cost of £3780 per month is apportioned to units on the basis of planned turnover.
3 Departmental fixed overhead of £2000 per month is directly attributable to the
department and is apportioned on the number of beds planned to be sold.
4 General fixed overheads of £2520 are also apportioned on the number of beds
planned to be sold. The directors of Winter plc believe this to be a fair
apportionment of the store’s central fixed overheads.
5 The cost of carriage inwards and the cost of beds vary directly with the number
of beds purchased.
Task 3
(a) Prepare a recommended monthly sales schedule in units which will maximize
the profitability of Winter plc’s bed department.
(b) Calculate the profit that will be reported per month if your recommendation is
implemented.
AAT Technician’s Stage
Fosterjohn Press Ltd is considering launching a new monthly magazine at a selling
price of £1 per copy. Sales of the magazine are expected to be 500 000 copies per month,
but it is possible that the actual sales could differ quite significantly from this estimate.
Two different methods of producing the magazine are being considered and nei-
ther would involve any additional capital expenditure. The estimated production
costs for each of the two methods of manufacture, together with the additional mar-
keting and distribution costs of selling the new magazine, are summarised below:
Method A Method B
Variable costs 0.55 per copy 0.50 per copy
Specific fixed costs £80 000 £120 000
per month per month
Semi-variable costs:
The following estimates have been obtained:
350 000 copies £55 000 per month £47 500 per month
It may be assumed that the fixed cost content of the semi-variable costs will remain
constant throughout the range of activity shown.
COST–VOLUME–PROFIT ANALYSIS 33
Question SM 9.5
Decision-making
and non-graphical
CVP analysis

The company currently sells a magazine covering related topics to those that will be
included in the new publication and consequently it is anticipated that sales of this
existing magazine will be adversely affected. It is estimated that for every ten copies
sold of the new publication, sales of the existing magazine will be reduced by one copy.
Sales and cost data of the existing magazine are shown below:
Sales 220 000 copies per month
Selling price 0.85 per copy
Variable costs 0.35 per copy
Specific fixed costs £80 000 per month
Required:
(a) Calculate, for each production method, the net increase in company profits
which will result from the introduction of the new magazine, at each of the
following levels of activity:
500 000 copies per month
400 000 copies per month
600 000 copies per month (12 marks)
(b) Calculate, for each production method, the amount by which sales volume of
the new magazine could decline from the anticipated 500 000 copies per
month, before the company makes no additional profit from the introduction
of the new publication. (6 marks)
(c) Briefly identify any conclusions which may be drawn from your calculations.
(4 marks)
(Total 22 marks)
ACCA Foundation Costing
Mr Belle has recently developed a new improved video cassette and shown below
is a summary of a report by a firm of management consultants on the sales poten-
tial and production costs of the new cassette.
Sales potential: The sales volume is difficult to predict and will vary with the price,
but it is reasonable to assume that at a selling price of £10 per cassette, sales would be
between 7500 and 10 000 units per month. Alternatively, if the selling price was
reduced to £9 per cassette, sales would be between 12 000 and 18 000 units per month.
Production costs: If production is maintained at or below 10 000 units per month,
then variable manufacturing costs would be approximately £8.25 per cassette and
fixed costs £12 125 per month. However, if production is planned to exceed 10 000
units per month, then variable costs would be reduced to £7.75 per cassette, but the
fixed costs would increase to £16 125 per month.
Mr Belle has been charged £2000 for the report by the management consultants
and, in addition, he has incurred £3000 development costs on the new cassette.
If Mr Belle decides to produce and sell the new cassette it will be necessary for
him to use factory premises which he owns, but are leased to a colleague for a
rental of £400 per month. Also he will resign from his current post in an electronics
firm where he is earning a salary of £1000 per month.
Required:
(a) Identify in the question an example of
(i) an opportunity cost,
(ii) a sunk cost. (3 marks)
(b) Making whatever calculations you consider appropriate, analyse the report
from the consultants and advise Mr Belle of the potential profitability of the
alternatives shown in the report.
Any assumptions considered necessary or matters which may require further
investigation or comment should be clearly stated. (19 marks)
(Total 22 marks)
Question SM 9.6
Decision-making
and non-graphical
CVP analysis

Savitt Ltd manufactures a variety of products at its industrial site in Ruratania. One
of the products, the LT, is produced in a specially equipped factory in which no
other production takes place. For technical reasons the company keeps no stocks of
either LTs or the raw material used in their manufacture. The costs of producing
LTs in the special factory during the past four years have been as follows:
(2001)
1998 1999 2000 (estimated)
(£) (£) (£) (£)
Raw materials 70 000 100 000 130 000 132 000
Skilled labour 40 000 71 000 96 000 115 000
Unskilled labour 132 000 173 000 235 000 230 000
Power 25 000 33 000 47 000 44 000
Factory overheads 168 000 206 000 246 000 265 000
Total production costs £435 000 £583 000 £754 000 £786 000
Output (units) 160 000 190 000 220 000 180 000
The costs of raw materials and skilled and unskilled labour have increased steadily
during the past four years at an annual compound rate of 20%, and the costs of fac-
tory overheads have increased at an annual compound rate of 15% during the
same period. Power prices increased by 10% on 1 January 1999 and by 25% on the
1 January of each subsequent year. All costs except power are expected to increase
by a further 20% during 2002. Power prices are due to rise by 25% on 1 January 2002.
The directors of Savitt Ltd are now formulating the company’s production plan
for 2002 and wish to estimate the costs of manufacturing the product LT. The
finance director has expressed the view that ‘the full relevant cost of producing LTs
can be determined only if a fair share of general company overheads is allocated to
them’. No such allocation is included in the table of costs above.
(a) use linear regression analysis to estimate the relationship of total production
costs to volume for the products LT for 2002 (ignore general company
overheads and do not undertake a separate regression calculation for each
item of cost), (12 marks)
(b) discuss the advantages and limitations of linear regression analysis for the
estimation of cost–volume relationships, (8 marks)
(c) comment on the view expressed by the finance director. (5 marks)
Ignore taxation.
ICAEW Elements of Financial Decisions
Question SM 10.1
Linear regression
analysis with
price level
adjustments
COST ESTIMATION AND COST BEHAVIOUR 35
Cost estimation and cost behaviour

Q Limited used an incremental budgeting approach to setting its budgets for the
year ending 30 June 2003.
The budget for the company’s power costs was determined by analysing the past
relationship between costs and activity levels and then adjusting for inflation of 6%.
The relationship between monthly cost and activity levels, before adjusting for
6% inflation, was found to be:
y = £(14 000 + 0.0025x2)
where y = total cost; and
x = machine hours
In April 2003, the number of machine hours was 1525 and the actual cost incurred
was £16 423. The total power cost variance to be reported is nearest to
A £3391 (A) B £3391 (F) C £3740 (F) D £4580 (F)
CIMA Management Accounting – Performance Management
The overhead costs of RP Limited have been found to be accurately represented by
the formula
y = £10 000 + £0.25x
where y is the montly cost and x represents the activity level measured in machine
hours.
Monthly activity levels, in machine hours, may be estimated using a combined
regression analysis and time series model:
a = 100 000 + 30b
where a represents the de-seasonalised monthly activity level and b represents the
month number.
In month 240, when the seasonal index value is 108, the overhead cost (to the
nearest £1000) is expected to be
A £35 000 B £37 000 C £39 000 D £41 000
(3 marks)
Question SM 10.2
Question SM 10.3
36 COST ESTIMATION AND COST BEHAVIOUR

The management of Springer plc is considering next year’s production and pur-
chase budgets.
One of the components produced by the company, which is incorporated into
another product before being sold, has a budgeted manufacturing cost as follows:
(£)
Direct material 14
Direct labour (4 hours at £3 per hour) 12
Variable overhead (4 hours at £2 per hour) 8
Fixed overhead (4 hours at £5 per hour) 20
Total cost 54 per unit
Trigger plc has offered to supply the above component at a guaranteed price of
£50 per unit.
Required:
(a) Considering cost criteria only, advise management whether the above
component should be purchased from Trigger plc. Any calculations should be
shown and assumptions made, or aspects which may require further
investigation should be clearly stated. (6 marks)
(b) Explain how your above advice would be affected by each of the two separate
situations shown below.
(i) As a result of recent government legislation if Springer plc continues to
manufacture this component the company will incur additional inspection
and testing expenses of £56 000 per annum, which are not included in the
above budgeted manufacturing costs. (3 marks)
(ii) Additional labour cannot be recruited and if the above component is not
manufactured by Springer plc the direct labour released will be employed
in increasing the production of an existing product which is sold for £90
and which has a budgeted manufacturing cost as follows:
(£)
Direct material 10
Direct labour (8 hours at £3 per hour) 24
Variable overhead (8 hours at £2 per hour) 16
Fixed overhead (8 hours at £5 per hour) 40
90 per unit
All calculations should be shown. (4 marks)
(c) The production director of Springer plc recently said:
‘We must continue to manufacture the component as only one year ago we
purchased some special grinding equipment to be used exclusively by this
component. The equipment cost £100 000, it cannot be resold or used else-
where and if we cease production of this component we will have to write
off the written down book value which is £80 000.’
Question SM 11.1
Make or buy
decision
MEASURING RELEVANT COSTS AND REVENUES FOR DECISION-MAKING 37
Measuring relevant costs and
revenues for decision-making

Draft a brief reply to the production director commenting on his statement.
(4 marks)
(Total 17 marks)
You have received a request from EXE plc to provide a quotation for the manu-
facture of a specialized piece of equipment. This would be a one-off order, in
excess of normal budgeted production. The following cost estimate has already
been prepared:
Note (£)
Direct materials:
Steel 10 m2 at £5.00
per sq. metre 1 50
Brass fittings 2 20
Direct labour
Skilled 25 hours at £8.00
per hour 3 200
Semi-skilled 10 hours at £5.00
per hour 4 50
Overhead 35 hours at £10.00
per hour 5 350
Estimating time 6 100
770
Administrative overhead at 20% of
production cost 7 154
924
Profit at 25% of total cost 8 231
Selling price 1155
Notes
1. The steel is regularly used, and has a current stock value of £5.00 per sq. metre.
There are currently 100 sq. metres in stock. The steel is readily available at a
price of £5.50 per sq. metre.
2. The brass fittings would have to be bought specifically for this job: a supplier
has quoted the price of £20 for the fittings required.
3. The skilled labour is currently employed by your company and paid at a rate of
£8.00 per hour. If this job were undertaken it would be necessary either to
work 25 hours overtime which would be paid at time plus one half or to reduce
production of another product which earns a contribution of £13.00 per hour.
4. The semi-skilled labour currently has sufficient paid idle time to be able to
complete this work.
5. The overhead absorption rate includes power costs which are directly related
to machine usage. If this job were undertaken, it is estimated that the machine
time required would be ten hours. The machines incur power costs of £0.75 per
hour. There are no other overhead costs which can be specifically identified
with this job.
6. The cost of the estimating time is that attributed to the four hours taken by the
engineers to analyse the drawings and determine the cost estimate given above.
7. It is company policy to add 20% on to the production cost as an allowance
against administration costs associated with the jobs accepted.
8. This is the standard profit added by your company as part of its pricing policy.
Question SM 11.2
Calculation of
minimum selling
price
38 MEASURING RELEVANT COSTS AND REVENUES FOR DECISION-MAKING

Required:
(a) Prepare, on a relevant cost basis, the lowest cost estimate that could be used as
the basis for a quotation. Explain briefly your reasons for using each of the
values in your estimate. (12 marks)
(b) There may be a possibility of repeat orders from EXE plc which would occupy
part of normal production capacity. What factors need to be considered before
quoting for this order? (7 marks)
(c) When an organisation identifies that it has a single production resource which
is in short supply, but is used by more than one product, the optimum
production plan is determined by ranking the products according to their
contribution per unit of the scarce resource.
Using a numerical example of your own, reconcile this approach with the
opportunity cost approach used in (a) above. (6 marks)
(Total 25 marks)
CIMA Stage Operational Cost Accounting
(a) Budgeted information for A Ltd for the following period, analysed by product,
is shown below:
Product Product Product
I II III
Sales units (000s) 225 376 190
Selling price (£ per unit) 11.00 10.50 8.00
Variable costs (£ per unit) 5.80 6.00 5.20
Attributable fixed costs (£000s) 275 337 296
General fixed costs, which are apportioned to products as a percentage of sales,
are budgeted at £1 668 000.
Required:
(i) Calculate the budgeted profit of A Ltd, and of each of its products. (5 marks)
(ii) Recalculate the budgeted profit of A Ltd on the assumption that Product
III is discontinued, with no effect on sales of the other two products. State
and justify other assumptions made. (5 marks)
(iii) Additional advertising, to that included in the budget for Product I, is
being considered.
Calculate the minimum extra sales units required of Product I to cover
additional advertising expenditure of £80 000. Assume that all other exist-
ing fixed costs would remain unchanged. (3 marks)
(iv) Calculate the increase in sales volume of Product II that is necessary in order
to compensate for the effect on profit of a 10% reduction in the selling price
of the product. State clearly any assumptions made. (5 marks)
(b) Discuss the factors which influence cost behaviour in response to changes in
activity. (7 marks)
(Total 25 marks)
Question SM 11.3
Impact of a
product
abandonment
decision and CVP
analysis

You work as a trainee for a small management consultancy which has been asked
to advise a company, Rane Limited, which manufactures and sells a single prod-
uct. Rane is currently operating at full capacity producing and selling 25 000 units
of its product each year. The cost and selling price structure for this level of activity
is as follows:
At 25 000
units output
(£ per unit) (£ per unit)
Production costs
Direct material 14
Direct labour 13
Variable production overhead 4
Fixed production overhead 8
Total production cost 39
Selling and distribution overhead:
Sales commission – 10% of sales value 6
Fixed 3
9
Administration overhead:
Fixed 2
Total cost 50
Mark up – 20% 10
Selling price 60
A new managing director has recently joined the company and he has engaged
your organisation to advise on his company’s selling price policy. The sales price of
£60 has been derived as above from a cost-plus pricing policy. The price was viewed
as satisfactory because the resulting demand enabled full capacity operation.
You have been asked to investigate the effect on costs and profit of an increase in
the selling price. The marketing department has provided you with the following
estimates of sales volumes which could be achieved at the three alternative sales
prices under consideration.
Selling price per unit £70 £80 £90
Annual sales volume (units) 20 000 16 000 11 000
You have spent some time estimating the effect that changes in output volume
will have on cost behaviour patterns and you have now collected the following
information.
Direct material: The loss of bulk discounts means that the direct material cost
per unit will increase by 15% for all units produced in the year if activity
reduces below 15 000 units per annum.
Direct labour: Savings in bonus payments will reduce labour costs by 10% for
all units produced in the year if activity reduces below 20 000 units per annum.
Sales commission: This would continue to be paid at the rate of 10% of sales price.
Fixed production overhead: If annual output volume was below 20 000 units,
then a machine rental cost of £10 000 per annum could be saved. This will be
the only change in the total expenditure on fixed production overhead.
Fixed selling overhead: A reduction in the part-time sales force would result in
a £5000 per annum saving if annual sales volume falls below 24 000 units. This
will be the only change in the total expenditure on fixed selling and
distribution overhead.
Variable production overhead: There would be no change in the unit cost for
variable production overhead.
Administration overhead: The total expenditure on administration overhead
would remain unaltered within this range of activity.
Stocks: Rane’s product is highly perishable, therefore no stocks are held.
Question SM 11.4
Price/output and
key factor
decisions
40 MEASURING RELEVANT COSTS AND REVENUES FOR DECISION-MAKING

Task 1
(a) Calculate the annual profit which is earned with the current selling price of £60
per unit.
(b) Prepare a schedule to show the annual profit which would be earned with
each of the three alternative selling prices.
Task 2
Prepare a brief memorandum to your boss, Chris Jones. The memorandum should
cover the following points:
(a) Your recommendation as to the selling price which should be charged to
maximise Rane Limited’s annual profits.
(b) Two non-financial factors which the management of Rane Limited should
consider before planning to operate below full capacity.
Another of your consultancy’s clients is a manufacturing company, Shortage
Limited, which is experiencing problems in obtaining supplies of a major
component. The component is used in all of its four products and there is a
labour dispute at the supplier’s factory, which is restricting the component’s
availability.
Supplies will be restricted to 22 400 components for the next period and the
company wishes to ensure that the best use is made of the available
components. This is the only component used in the four products, and there
are no alternatives and no other suppliers.
The components cost £2 each and are used in varying amounts in each of the
four products.
Shortage Limited’s fixed costs amount to £8000 per period. No stocks are
held of finished goods or work in progress.
The following information is available concerning the products.
Maximum Product A Product B Product C Product D
demand 4000 units 2500 units 3600 units 2750 units
per period (£ per unit) (£ per unit) (£ per unit) (£ per unit)
Selling price 14 12 16 17
Component costs 4 2 6 8
Other variable costs 7 9 6 4
Task 3
(a) Prepare a recommended production schedule for next period which will
maximise Shortage Limited’s profit.
(b) Calculate the profit that will be earned in the next period if your recommended
production schedule is followed.
AAT Technicians Stage

42 THE APPLICATION OF LINEAR PROGRAMMING TO MANAGEMENT ACCOUNTING
MF plc manufactures and sells two types of product to a number of customers. The
company is currently preparing its budget for the year ending 31 December 2003
which it divides into 12 equal periods.
The cost and resource details for each of the company’s product types are as follows:
Product type M Product type F
£ £
Selling price per unit 200 210
Variable costs per unit
Direct material P (£2.50 per litre) 20 25
Direct material Q (£4.00 per litre) 40 20
Direct labour (£7.00 per hour) 28 35
Overhead (£4.00 per hour) 16 20
Fixed production cost per unit 40 50
Units Units
Maximum sales demand in period 1 1000 3000
The fixed production cost per unit is based upon an absorption rate of £10 per
direct labour hour and a total annual production activity of 180 000 direct labour
hours. One-twelfth of the annual fixed production cost will be incurred in period 1.
In addition to the above costs, non-production overhead costs are expected to be
£57 750 in period 1.
During period 1, the availability of material P is expected to be limited to
31 250 litres. Other materials and sufficient direct labour are expected to be avail-
able to meet demand.
It is MF plc’s policy not to hold stocks of finished goods.
Required:
(a) Calculate the number of units of product types M and F that should be
produced and sold in period 1 in order to maximize profit. (4 marks)
(b) Using your answer to (a) above, prepare a columnar budgeted profit statement
for period 1 in a marginal cost format. (4 marks)
After presenting your statement to the budget management meeting, the produc-
tion manager has advised you that in period 1 the other resources will also be lim-
ited. The maximum resources available will be:
Material P 31 250 litres
Material Q 20 000 litres
Direct labour 17 500 hours
It has been agreed that these factors should be incorporated into a revised plan
and that the objective should be to make as much profit as possible from the
available resources.
Question SM 12.1
Optimal output
and calculation of
shadow prices
using graphical
approach
The application of linear programming
to management accounting

Required:
(c) Use graphical linear programming to determine the revised production plan
for period 1. State clearly the number of units of product types M and F that are
to be produced. (10 marks)
(d) Using your answer to part (c) above, calculate the profit that will be earned
from the revised plan. (3 marks)
(e) Calculate and explain the meaning of the shadow price for material Q. (5 marks)
(f) Discuss the other factors that should be considered by MF plc in relation to the
revised production plan. (4 marks)
(Total 30 marks)
A company manufactures two products (X and Y) in one of its factories. Production
capacity is limited to 85 000 machine hours per period. There is no restriction on
direct labour hours.
The following information is provided concerning the two products:
Product Product
X Y
Estimated demand (000 units) 315 135
Selling price (per unit) £11.20 £15.70
Variable costs (per unit) £6.30 £8.70
Fixed costs (per unit) £4.00 £7.00
Machine hours (per 000 units) 160 280
Direct labour hours (per 000 units) 120 140
Fixed costs are absorbed into unit costs at a rate per machine hour based upon
full capacity.
Required:
(a) Calculate the production quantities of Products X and Y which are required per
period in order to maximise profit in the situation described above. (5 marks)
(b) Prepare a marginal costing statement in order to establish the total contribution
of each product, and the net profit per period, based on selling the quantities
calculated in (a) above. (4 marks)
(c) Calculate the production quantities of Products X and Y per period which
would fully utilise both machine capacity and direct labour hours, where the
available direct labour hours are restricted to 55 000 per period. (The limit of
85 000 machine hours remains.) (5 marks)
(Total 14 marks)
ACCA Foundation Paper 3
Question SM 12.2
Limiting factor
optimum
production and
the use of
simultaneous
equations where
more than one
scarce factor
exists
THE APPLICATION OF LINEAR PROGRAMMING TO MANAGEMENT ACCOUNTING 43

44 ACTIVITY-BASED COSTING
The following budgeted information relates to Brunti plc for the forthcoming period:
Products
XYI YZT ABW
(000) (000) (000)
Sales and production (units) 50 40 30
(£) (£) (£)
Selling price (per unit) 45 95 73
Prime cost (per unit) 32 84 65
Hours Hours Hours
Machine department
(machine hours per unit) 2 5 4
Assembly department
(direct labour hours
per unit) 7 3 2
Overheads allocated and apportioned to production departments (including ser-
vice cost centre costs) were to be recovered in product costs as follows:
Machine department at
£1.20 per machine hour
Assembly department at
£0.825 per direct labour hour
You ascertain that the above overheads could be re-analysed into ‘cost pools’ as
follows:
Quantity
for the
Cost pool £000 Cost driver period
Machining services 357 Machine hours 420 000
Assembly services 318 Direct labour hours 530 000
Set-up costs 26 Set-ups 520
Order processing 156 Customer orders 32 000
Purchasing 84 Suppliers orders 11 200
941
You have also been provided with the following estimates for the period:
Products
XYI YZT ABW
Number of set-ups 120 200 200
Customer orders 8000 8000 16 000
Suppliers’ orders 3000 4000 4 200
Question SM 13.1
Preparation of
conventional
costing and ABC
profit statements
Activity-based costing

Required:
(a) Prepare and present profit statements using:
(i) conventional absorption costing; (5 marks)
(ii) activity-based costing; (10 marks)
(b) Comment on why activity-based costing is considered to present a fairer
valuation of the product cost per unit. (5 marks)
(Total 20 marks)
In a marginal costing system only variable costs would be assigned to products or
services, in which case management may rely on a contribution approach to decisions.
Required:
(a) Explain and discuss the contribution approach to decisions giving brief examples
and drawing attention to any limitations. (6 marks)
A full absorption costing system would involve the assignment of both variable and
fixed overhead costs to products. A traditional full absorption costing system typi-
cally uses a single volume related allocation base (or cost driver) to assign overheads to
products. An activity based costing (ABC) system would use multiple allocation bases
(or cost drivers), taking account of different categories of activities and related overhead
costs such as unit, batch, product sustaining and facility sustaining.
Required:
(b) Describe the likely stages involved in the design and operation of an ABC system.
(4 marks)
(c) Explain and discuss volume related allocation bases (or cost drivers), giving an
example of one within a traditional costing system. Contrast this with the
multiple allocation bases (or cost drivers) of an ABC system. (6 marks)
(d) Briefly elaborate on the different categories of activities and related overhead
costs, such as unit, batch, product sustaining and facility sustaining, which may
be used in an ABC system. (4 marks)
(Total 20 marks)
The following information provides details of the costs, volume and cost drivers for
a particular period in respect of ABC plc, a hypothetical company:
Product X Product Y Product Z Total
1. Production and sales (units) 30 000 20 000 8 000
2. Raw material usage (units) 5 5 11
3. Direct material cost £25 £20 £11 £1 238 000
4. Direct labour hours 11/3 2 1 88 000
5. Machine hours 11/3 1 2 76 000
6. Direct labour cost 8 £12 £6
7. Number of production runs 3 7 20 30
8. Number of deliveries 9 3 20 32
9. Number of receipts (2 × 7)a 15 35 220 270
10. Number of production orders 15 10 25 50
11. Overhead costs:
Set-up 30 000
Machines 760 000
Receiving 435 000
Packing 250 000
Engineering 373 000
£1 848 000
a The company operates a just-in-time inventory policy, and receives each component once per
production run.
Question SM 13.2
Question SM 13.3
Computation of
product costs for
traditional and
ABC systems
ACTIVITY-BASED COSTING 45

46 ACTIVITY-BASED COSTING
In the past the company has allocated overheads to products on the basis of direct
labour hours.
However, the majority of overheads are more closely related to machine hours
than direct labour hours.
The company has recently redesigned its cost system by recovering overheads
using two volume-related bases: machine hours and a materials handling overhead
rate for recovering overheads of the receiving department. Both the current and the
previous cost system reported low profit margins for product X, which is the com-
pany’s highest-selling product. The management accountant has recently attended
a conference on activity-based costing, and the overhead costs for the last period
have been analysed by the major activities in order to compute activity-based costs.
From the above information you are required to:
(a) Compute the product costs using a traditional volume-related costing system
based on the assumptions that:
(i) all overheads are recovered on the basis of direct labour hours (i.e. the com-
pany’s past product costing system);
(ii) the overheads of the receiving department are recovered by a materials
handling overhead rate and the remaining overheads are recovered using
a machine hour rate (i.e. the company’s current costing system).
(b) Compute product costs using an activity-based costing system.
(c) Briefly explain the differences between the product cost computations in
(a) and (b).

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